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Efficiency of Foreign Exchange Markets and Measures of Turbulence

Listed author(s):
  • Jacob A. Frenkel
  • Michael L. Mussa

Since the move to generalized floating in1973, exchange rates between major currencies have displayed large fluctuations. This turbulence of foreign exchange rates is an important concern of government policy and its explanation is a challenge for theories of foreign exchange market behavior. In Section I of this paper, we document the extent of turbulence in foreign exchange markets by examining (i) the magnitude of short-run variations in exchange rates relative to other measures of economic variability; (ii) the degree of divergence between actual and expected changes in exchange rates; and (iii) the extent to which exchange-rate movements have diverged from movements of relative national price levels. In Section II, we provide a general explanation of this turbulence in terms of the modern "asset market theory" to exchange-rate determination. This theory emphasizes that exchange rates, like the prices of other assets determined in organized markets, are strongly influenced by the market's expectation of future events. In this context, we also discuss the narrower technical question of "foreign exchange market efficiency." Finally, in Section III, we address the question of whether turbulence in the foreign exchange markets has been "excessive" and what policy measures can (or should) be taken to reduce it.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0476.

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Date of creation: May 1980
Publication status: published as Frenkel, Jacob A. and Mussa, Michael L. "The Efficiency of Foreign Exchange Markets and Measures of Turbulence." The American Economic Review, Vol. 70 , No. 2, (May 1980), pp. 374-381.
Handle: RePEc:nbr:nberwo:0476
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  1. Stanley W. Black, 1972. "International money markets and flexible exchange rates," Staff Studies 70, Board of Governors of the Federal Reserve System (U.S.).
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